27 January 2009

Published in: Regulation - supervision

Europe races against time to resolve group support issue

Meetings have started in Brussels to thrash out Solvency II sticking points, especially the big one, group support. Can they prevent the directive being delayed? Jessica Baylis reports.

The proposed group support regime of Solvency II has divided Europe. The big insurance players and a small number of member states say it is fundamental to the directive. A larger number of member states -- enough to block legislation -- disagree. Last week, the so-called "trialogue" between the European Commission, Council and Parliament started in Brussels, in an attempt to finalise the text for the directive and overcome stumbling blocks like group support.

The representatives of the three bodies in effect have until the early spring to complete their task because European parliamentary elections in June could lead to delays in the Solvency II timetable.

"I think thus far the positions have been fairly polarised, the one camp wanting to have a significantly advanced form of group support and the other camp not wanting to have anything to do with group support," says Klaas Knot, division director at De Nederlandsche Bank and a member of the managing board of the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS). "The second camp has prevailed for now since group support has been deleted from the Council's proposals, but I don't think this is a stable equilibrium."

The group support regime is an optional sub-set of the group supervision proposals of Solvency II. Its key feature - and what is causing the disagreement - is that insurance groups would have to meet the solvency capital requirement (SCR) at a group level only. Groups' subsidiaries, therefore, would be required to hold capital sufficient to cover only the minimum capital requirement (MCR), and be reliant on a transfer of funds from the parent, should more be needed.

In short, those who support such a measure - the large insurance companies and the European Parliament and Commission - say it is necessary to realise diversification benefits needed to create an efficient and competitive European insurance market in line with transnational realities. Those that oppose it - the group of 12 led by Poland and Spain - fear that if the parent gets into trouble, it will not be willing, or will not be able, to transfer the necessary funds.

The Czech Republic is one of the countries that oppose group support as it stands. Zuzana Silberova, insurance supervision division director at the Czech National Bank, says the proposal is "ambitious and revolutionary" and essentially unacceptable. "The strengthening of group supervision simply cannot be viable when we shift the competencies from the host supervisor while leaving him with all the responsibility for the undertakings over which he is authorised."

The key question is, or course, how strong is the opposing states' argument? No-one is denying the economic benefits of diversification. As Knot says, "From an economic perspective there would be no problem because you wouldn't have legal boundaries and then it would be clear: you would have implicit group support and you would have diversification benefits."

It's politics, not economics

Of course this debate is not just economic: it is highly political. "Here national boundaries play a role, so there is a conflict," says Knot, "Supervisors are held accountable for protecting policy holders within their national boundary."

There is, therefore, an underlying concern about the relative powers of lead and host supervisors, compounded by the fact that most major groups are headquartered in a small number of western European countries (UK, Germany, Netherlands, France and Italy). As Paul Barrett, assistant director of financial regulation at the Association of British Insurers (ABI), says, the financial crisis "has made people very cautious about how this will work in practice."

For Barrett, half the battle is about reassurance, "Confidence at the moment can be as much an emotional thing as a rational and factual thing. There are a number of countries that have no pan-European group headquarters and no significant domestic industry. In Poland, for example, there is one incumbent player which is a former state insurer, and all the other insurers are branches or subsidiaries of overseas insurance groups. So clearly their concern is of the unknown."

Dominique Thienpont, who is an EU official in the Insurance and Pensions Unit of the Internal Market Directorate-General and plays a key role in the Solvency II negotiations, is responsible for matters related to group supervision. He says that concerns over fund transfers is understandable given past experience: "We can see why they have these concerns. In the past, when some local supervisors have tried to obtain support or help from the parent, in a number of cases they have not managed to obtain it."

He is keen to stress, however, a number of measures have been included in the Solvency II proposal to prevent the group supervisor blocking a capital transfer to a subsidiary. "The supervisor of the parent will not be able to block a transfer under the group support regime,," he says. "We have one article in the directive which explicitly states that when a transfer of capital has been requested by a local supervisor, the group supervisor has a duty to assist and he must take all measures possible to force the parent to transfer the money promised under the regime. This includes the most radical measure which is to withdraw the licence and to close the parent down."

But this does not answer the question of what happens if the parent is unable to transfer funds. "The main answer from the industry," says Thienpont, "is that diversification effects mean that if a difficulty arises in some subsidiaries, it will be compensated by other undertakings, so that parent undertakings should not normally end up without enough money."

Impact of the financial crisis

The timing of this debate is not on the side of the industry, however, as the financial crisis has thrown into question this argument. What if the whole group gets into difficulty? Compared with 12 months ago, it is now harder to argue that this is unlikely. Dutch insurer, Aegon, is a case in point. Having lost 75% of its share value in a year, the group had to accept E3bn ($3.88bn;£2.8bn) from the Dutch government just three months ago. Diversification effects were irrelevant.

Indeed, while a small number of countries, most notably Poland and Spain, have always rejected group support, until six months ago, most remained open minded. The last six months of 2008, however, tipped the balance for countries such as Germany and Sweden.

The arguments for and against have been hotly debated in Brussels and have reached a stalemate. For the directive to become legislation, the European Parliament, Council and Commission all have to vote in favour of the same text. At present, the Parliament and Commission have adopted texts that include group support. The Council adopted a text that removed group support altogether last December. The trialogue that is taking place at the moment involves a series of meetings and committees with representatives of the three bodies trying to find a common stance. Group support is not the only point of disagreement, but it's the main one.

Knot says there will be a compromise: "Probably it's something where the concept is embraced but the application will be extremely limited. If I look from a distance, it would be a victory for the countries that oppose it. It will be significantly watered down."

This will come as a huge blow to many in the industry. Outwardly, its proponents say they will take a strong stance. The Commission's official position, and indeed much of the industry's, is that they are not willing to compromise. The ABI's director general, Stephen Haddrill, said in a statement, for example, that Solvency II without group support is a "waste of time" [see our story in Regulation/supervision on 5 December 2008, "French official rebuts ABI claim on Solvency II"].

Klaas Knot of De Nederlandsche Bank and CEIOPS: group support "will be significantly watered down."

Privately, however, they accept that a compromise, not on their terms, maybe be a political reality. The ABI is one of the more vocal advocates of group support, but Barrett concedes, "It may be necessary to start with something that is a bit more constrained and a bit less ambitious. We've been pressing very hard not to accept merely the lowest common denominator. But it is a reality that if we do want to take a step forward, we have to get a sufficient measure of support behind the directive."

Whether a watered-down version of group support will be acceptable to opposing member states will of course depend on what form any compromise between Council and Parliament would take.

What sort of compromise?

There are several ideas being floated. One option is an opt-in system. Parent companies within those countries that opt in to the group support can apply it to any subsidiaries within their country and any other country that has also signed up. The political viability of this is dubious, however, "My understanding is that a number of member states are not in favour of an optional system," says Thienpont, "They are afraid that if the system of group support is introduced in one state, for example, then this would lead to a significant disadvantage to groups from states which would not introduce the system."

Alternatively, group support could be maintained but altered to placate the concerns of local regulators. For example, instead of the possibility to cover the whole difference between the MCR and the SCR of the local subsidiaries, group support could cover just half this or a quarter. Such a proposal does run the risk of pleasing no-one: "If you go too far, you end up with a regime which is so constrained that it doesn't really deliver advantages to the industry," says Thienpont.

One proposal being aired would almost certainly be acceptable to the group of 12. This would be to keep group support, but alter the balance of powers."Some member states," explains Thienpont, "have claimed they would be prepared to accept the regime if we give the final decision on everything to local supervisors." But this it would seem to some, strips group support of its raison d'etre. "What would be the value for industry of such a system?" He explains that such measures would simply duplicate the articles on ancillary own funds - funds which are approved by the local supervisor and can be provided by the parent. "We would call it group support, but why have we invented a new word?"

A further option is to introduce Solvency II without group support, and then introduce group support later. This could take various forms. It is unlikely, for example, that no mention of group support would be acceptable to industry. As Barrett says, "It's like saying we'll do half the house extension now and the other half later. I think frankly that you've got to have a plan that's a bit more concrete than that."

Lucas Ziewer of Oliver Wyman: "If the [Solvency II] project gets delayed, even by a year or two, people who are drivers of better risk management in insurance companies will lose a lot of credibility and momentum."

Including some, but not all, aspects of the group support regime, with the hope of building on this once Solvency II is implemented, is what the pragmatic supporters of the group support regime are proposing, according to Yann Le Pallec, head of insurance ratings at Standard and Poor's Europe, "They're trying to revive the lead supervisor concept but without introducing the ability for groups to maintain lower levels of capital within their subsidiaries. This would make it easier in the future to reintroduce the [full] group support regime."

Another way of delaying group support is to include it in the directive but its use would be conditional on further measures being introduced. Thienpont explains, "Those further measures might be, for example, the introduction in the future of an EU-wide insurance guarantee scheme." This, he says, would mean all EU countries having a fund to which undertakings at a national level are contributing at normal times. If an undertaking goes bust, policy holders can be compensated with money from the fund. This is not without its complications, but does remain a serious option. "That will be a response to those member states which are concerned that if the group support regime does not work properly, their policy holders will be at risk," he explains.

These are just some of the main options that have been envisaged. In reality, the risk of delaying Solvency II means there must be flexibility in the negotiations, "How long industry will maintain their request for a very pure group support regime is not absolutely clear to us because they are probably starting to realise that there is a danger in being too aggressive in their request, and that the danger is that we will have the elections for the EU Parliament in June [before a compromise is met]," says Thienpont.

Serious delays possible

This would mean that Solvency II negotiations would be put on hold for months, and a different Parliament and Commission may have different views, further complicating negotiations. "If the deadline is missed then we're looking at serious delays," says Knot. "I really think that each day it would be delayed is a problem. As the crisis demonstrates, we, as supervisors, need risk-based information on the financial health of our insurance companies and most of the EU doesn't have that today. It is urgently needed."

Lucas Ziewer, partner at Oliver Wyman, points out that it's not so much the financial health of the industry that is at risk if there is a delay, but the ability of risk managers to drive change. "Big investments have been made and chief risk officers have used a lot of the momentum of Solvency II. To some extent they've put their credibility in that process. If the project gets delayed, even by a year or two, people who are drivers of better risk management in insurance companies will lose a lot of credibility and momentum."

There is more optimism now the Czech Republic has taken over the EU presidency: many perceive the French presidency to have been detrimental to Solvency II and lacking a spirit of compromise. For example, in December British MEP Sharon Bowles accused the French of engineering the removal from the draft directive of group support - which it originally supported - in return for the group of 12 supporting its approach on the amount of capital to be held as reserves against equity holdings [see our story in Regulation/supervision of 8 December 2008, "British MEP accuses French over deal on group supervision"].

Silberova explains that the Czech presidency has made Solvency II a priority, "The goal the Czech presidency will try to achieve is to conclude the negotiations before the European elections for the European Parliament [in June 2009]. If it succeeds, the delay to Solvency II should not be substantial, just a matter of months."

For Knot, what is at stake here is not just a matter of timing, "Insurance is the business of diversification - much more than on the banking side. Disallowing geographical diversification, which is essentially what you're doing by taking a national perspective, means you are undermining one of the fundamental laws that underlies the business logic of insurance."

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